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The Commissioner of Taxation’s power to issue notices under section 260-5 of Schedule 1 to the Taxation Administration Act 1953 (otherwise known as garnishee notices) is one of the ‘firmer action’ tools that the Australian Taxation Office (ATO) has at its disposal to enforce the tax law and ensure prompt collection of tax debts. The issue of these notices also provides an avenue for the ATO to create a de facto priority in bankruptcy and corporate insolvency.

This privileged position thus frustrates the Commonwealth Government’s clear policy of encouraging corporate rescue, particularly during the COVID-19 crisis when viable businesses need all the help they can get to explore survival.

Case law on the validity of garnishee notices

There is a breadth of case law entrenching the wide reach of the ATO’s garnishee power.

One of the leading authorities on the validity of notices served by the ATO is the Federal Court’s 1989 decision in Deputy Commissioner of Taxation (DCT) v Donnelly. In that case, the Court had to consider the ATO’s status as a priority creditor by determining whether the ATO was a ‘secured creditor’ for the purposes of section 58(5) of the Bankruptcy Act 1966. Justice Hill noted the striking similarity between the effect of a section 218 notice (predecessor to section 260-5) and garnishee proceedings, which was influential in His Honour’s conclusion that the ATO was a secured creditor.

In the 1999 decision of the Full Court of the Federal Court in Macquarie Health Corporation Ltd v Commissioner of Taxation, the Full Court held that just as the service of a section 218 notice made the ATO a secured creditor for the purposes of the bankruptcy law in Donnelly, so it made the ATO a secured creditor for the purposes of section 471C of Corporations Law (now section 471C of the Corporations Act 2001, see our paper for further detail). Accordingly, for the purposes of the Bankruptcy Act 1966 and the Corporations Act 2001, a charge is created in the ATO’s favour by virtue of the service of the garnishee notice, so that the ATO becomes a secured creditor for bankruptcy purposes, and on a liquidation.

The ATO’s discretion

In Practice Statement Law Administration PS LA 2011/18 (as updated on 3 July 2014), the ATO sets out its practice in relation to the issuing of garnishee notices. The ATO recognises that the issue of a garnishee notice is an exercise of a coercive power, so care must be taken when exercising this power.

The ATO’s practice is that where the tax debtor is subject to external administration subsequent to the issue of a garnishee notice, it will not ordinarily withdraw that notice. In that regard, the notice will continue to operate on the relevant amounts under the notice. Where it is apparent that the tax debtor is about to enter or become subject to external administration, the ATO will only issue a garnishee notice in respect of amounts due (or expected to become due), after having taken into account a number of factors. These factors include the need to protect the revenue and the expected impact that the garnishee notice will have on the tax debtor’s unrelated, arm’s-length creditors, in terms of their likely receipts from the tax debtor’s insolvency administration.

Review of the ATO’s decision to issue garnishee notices

There are a number of cases where the courts have reviewed the ATO’s decision to issue garnishee notices pursuant to the Administrative Decisions (Judicial Review) Act 1977.

One such case where the taxpayer was successful was the 2013 Federal Court decision in Denlay v Commissioner of Taxation, which involved Part IVC (Taxation objections, reviews and appeals) of the Taxation Administration Act 1953. The ATO obtained judgment in respect of the taxpayer’s outstanding debts; however, enforcement of the judgment was stayed by the Supreme Court of Queensland pending the outcome of the Federal Court income tax appeals. The stay was granted because enforcement of the judgment would likely cause the bankruptcy of the taxpayers and result in inability to prosecute their challenges to the assessments. The ATO challenged the stay and was unsuccessful, so then proceeded to issue garnishee notices requiring remittance to the ATO of the remaining amounts held in each taxpayer’s superannuation account.

Justice Logan held that the order of the Supreme Court of Queensland to grant a stay was a relevant consideration that was not taken into account by the ATO. Justice Logan said that the considerations for a court when granting a stay of execution are equally relevant ones for the ATO to take into account when deciding whether or not to issue a garnishee notice. Further, given that the appeals were at an advanced stage, the merits of a Part IVC application were a ‘highly relevant consideration’. Justice Logan held, quashing the decision to issue the notices, that the ATO’s decision to issue notices under section 260-5 was so unreasonable that no decision-maker, acting reasonably, could have so decided. However, Justice Logan made it clear that the outcome was based on the facts and the need for the ATO to have taken into account the considerations relevant to a stay. In that regard, the great weight that is given by courts to the legislative policy of the tax law which accords priority to the recovery of tax debts notwithstanding the existence of Part IVC of the Taxation Administration Act 1953 proceedings, will seem inequitable to the vast majority of taxpayers who bring appeals on bona fide grounds.

The impact on corporate rescue

The issue of whether tax debts should be given priority in a corporate insolvency has been debated extensively. In 1987–88, the Australian Law Reform Commission conducted an extensive inquiry into insolvency which resulted in the Harmer Report. The Report recommended the tax priority be abolished and set forth a number of arguments in favour of its removal. One was the concern that priority would discourage attempts to rehabilitate companies in financial distress, undermining the Voluntary Administration regime proposed in the Harmer Report.

In the last two years, there have been key reforms implemented which together represent the most significant change to Australia’s corporate rescue laws since 1993. These reforms include amendments prohibiting ‘ipso facto’ clauses on the event of Voluntary Administration, Receivership, or a Scheme of Arrangement under Part 5.1 Corporations Act 2001 and, in relation to insolvent trading, the ‘safe harbour’ carve-out from liability under section 588G Corporations Act 2001. Both reforms resulted from a clear government agenda to promote corporate rescue, and early action to deal with financial distress, as part of an enterprise culture. In the last few months, the Government has introduced a Bill to incorporate into the Corporations Act 2001 a new restructuring procedure for small business, aimed to assist companies that meet the eligibility requirements by allowing the directors to stay in control, under the oversight of an insolvency practitioner, while a plan is formulated to put to creditors.

The tension between the ATO’s focus on revenue protection on the one hand and the legitimate objectives of corporate insolvency law on the other, will continue to escalate in the current COVID-19 economic climate where many businesses are likely to experience considerable financial hardship, even after the unprecedented Federal and State government stimulus measures for business are implemented. The Government has made amendments to personal and corporate insolvency laws to provide temporary relief to debtors in connection with compulsory insolvency processes. This applies to statutory demand and bankruptcy notices, as well as providing a temporary ‘safe harbour’ from insolvent trading liability (ended on 31 December 2020).

For this reason, it is considered imperative that the ability of ATO to achieve this de facto priority and thereby frustrate corporate rescue attempts, be removed, so that companies that show signs of long-term viability have the best chance of survival post-insolvency.

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